When a Document Says It Isn’t a Contract, It Isn’t a Contract

In his lesser-known recent opinion in which ostriches make an appearance, Judge Richard Posner of the U.S. Seventh Circuit Court of Appeals considered whether a memorandum of understanding and a letter of intent formed binding contracts. As you might have guessed from this post’s title—which is a quote from the opinion—the answer was no.

(In his better-known ostrich opinion, Judge Posner benchslapped one of the lawyers arguing before the court for disregarding precedent that was detrimental to his case. The opinion, in which Judge Posner compares the lawyer to an ostrich with his head in the sand, is complete with pictures. See this post at Above the Law for the picture of man in suit with head in sand.)

The Memorandum of Understanding and Letter of Intent

The parties in BPI Energy Holdings, Inc. v. IEC (Montgomery), LLC held discussions about a potential business deal which never fully materialized. Under the proposed arrangement, BPI, which was in the natural gas extraction business, would transfer options to purchase certain coal mining rights to IEC, which is in the coal mining business. In return, IEC would enter into gas extraction leases on commercial terms that were favorable to BPI.

During the course of the negotiations the parties signed a memorandum of understanding and a letter of intent, both of which stated that they were non-binding. It’s common to sign non-binding documents early in the deal-making process in order to memorialize the parties’ understanding of major deal terms while continuing to negotiate final binding documents.

BPI’s Breach of Contract Claim

BPI jumped the gun somewhat and began transferring coal rights to IEC before a binding contract was agreed to. The relationship eventually soured and a definitive contract was never signed. BPI sued IEC for breach of contract as well as for fraud.

The memorandum of understanding and the letter of intent, had they singly or jointly formed a legally enforceable contract, would in essence have obligated Drummond [i.e., IEC] to swap its gas extraction leases for BPI’s coalmining options on mutually favorable terms. … But both the memorandum of understanding and the letter of intent unambiguously disclaim the creation of enforceable rights. A document can be a contract without calling itself a contract; many letters of intent create contractual rights. But when a document says it isn’t a contract, it isn’t a contract.

(slip opinion at pages 5-6 with citations omitted).

Lessons to Be Learned

Don’t be lulled into acting as if you have a binding deal before the deal is closed. If the other side pulls out, you might not have a legal remedy even if you’ve begun to perform your obligations under the unfinished contract.

Make sure you clearly and unambiguously state that non-binding terms in a memorandum of understanding or letter of intent are in fact not binding. The title of this post notwithstanding, plenty of similar documents have been held by courts to be binding when the parties weren’t crystal clear.

If you’re a lawyer appearing before the Seventh Circuit, don’t ignore the elephant in the room when you make your arguments. After causing a minor uproar in legal circles last month with his ostrich photos, Judge Posner was much more tame in this opinion and merely referred to IEC’s failure to cite precedent as “ostrich tactics.&rdquo